Episode 21: The Debt Reset

It’s the proverbial elephant in the room. Everybody knows it’s there, but nobody wants to talk about it. When it is discussed (which is rare), it’s brushed aside, made to look like it’s under control, or kicked a bit further down the road. Meanwhile, it just keeps growing. Those that do see it as a problem tend to misdiagnose its cause, which assures their proposed remedies will miss the mark.

We’re talking of course about the national debt.

Now, as if it were a last-ditch, throw-your-hands-up-in-exasperation kind of attempt, there’s been talk of simply “resetting” the debt. We are reminded of Boromir at the outset of the Fellowship: “One does not simply reset the debt…” 

In this episode, Keith and John give the debt the attention it deserves. Key points mentioned include:

• What is the origin and cause of the rising debt? And can it really be managed?
• Asking the wrong questions about the debt
• What metrics should we be monitoring to see if we’re close to a debt collapse?
• Can gold play a role in the solution?

Additional Resources:

• Resetting the Federal Debt
• Marginal Productivity of Debt
• How Falling Interest Drives the Consumption of Capital
• Gold Bonds to Avert Financial Armageddon

Episode Transcript

John: Hello again and welcome to the Gold Exchange podcast. I’m John Flaherty. I’m here with Keith Wiener, founder and CEO of Monetary Metals. In today’s episode, we are going to talk about the alleged debt reset. This, of course, is a buzz phrase that we continually see running through the headlines and we’d like to get Keith’s take. We’ll highlight portions of Keith’s recent article on the subject. And of course, if there is to be a reset, we’ll see how gold might play a role.

So, Keith, everyone can see the US national debt is exploding like a hockey stick. The official number recently is twenty-eight trillion, but adding unfunded liabilities puts us well over that, well over one hundred trillion even at that lower number of twenty-eight trillion. That adds up to close to three hundred thousand per working individual in the United States. So if an eighth-grader knows that this can’t be paid back this debt, then the natural question becomes how will it end?

In the mainstream, you see basically three classic doors. So let’s talk door number one. Can the debt be managed by a steady and planned inflation?

Keith: So the problem with that solution, if that’s to be deemed the solution, is that the process of inflation is the process of borrowing more. And sure maybe each dollar of debt, but you owe may be worth a bit less, but you owe exponentially more of them. So this is the can we get out of the hole by digging it deeper? In theory, I guess you could dig all the way through the Earth and out the other side. But in practice, as you’re digging deeper and deeper, eventually you’re going to run out of food, water and fail. So, no, I don’t think a study planned so-called inflation can solve the problem.

John: So another common theory is the revaluing of gold kind of anchoring the currency to a new higher price of gold. For instance, you’ll see folks take the M1 or some other measure of the dollar sloshing around in the system and divide by a hypothetical amount of gold ounces out there. And you’ll see ratios of anywhere from 30 to 60 thousand or more. Is that a solution?

Keith: Well, first of all, it’s kind of like numerology and the world doesn’t work that way. So, number one, they’re just not even wrong in that sense. But aside from that, people think back in the time of the gold standard, there was a price of gold. And of course, today there’s a price of gold. And so they think, OK, well, it worked then why don’t we just return to that now? But at the time, it was not a price of gold. All they did was they standardized the size of the gold deposit. You brought gold to the bank. There was no question that you had a right to redeem your gold when you wanted it. And all they did was they standardized unit of account. It’s like saying a bite is eight bits. A packet on the Internet is a thousand and twenty four bytes per page, and Microsoft Word might be 50 or 100 lines of text. All you’re doing is kind of standardizing things so that when two people say, oh, this is two feet long, they both know what they mean.

But back then, that’s what it was. It was the standardized unit of account. Today, of course, there’s a price. Gold is not the unit of account. The dollar is the unit of account and every dollar sloshing around in the system did not begin life as a gold deposit. Therefore, there’s no gold to redeem today. The price of gold, and there is a price, is set by a third party. It has nothing to do with the currency. If you have some currency, you’re not going to the currency issuer and saying redeem me. You’re going to a third party and say trade me. Maybe the third party is willing to trade, maybe he isn’t. And that’s why if the currency issuer says, well, from now on, we’re going to have an official policy of saying that gold is going to be fifty thousand dollars an ounce or pick your number, it’s no better than King Canute saying we’re going to have an official policy that sea level is going to be two meters below sea level.

Well, you could say that, but it isn’t going to work. Every attempt at fixing a price or other currency or not currency, but will just focus on central banks that peg currencies, every last one has failed. Without exception.

John: So the third one we often hear, door number three, we’ll call it, is hyperinflation. We’ll talk a little bit more about that in a bit. But will hyperinflation solve the problem?

Keith: It’s kind of like your friend has a mosquito on his forehead and so you take a giant steel pipe and wind up and whack him in the head as you possibly can. Does not solve the problem of the mosquito bite?

Well, yeah, maybe, but you’ve just broken his head open with steel pipe. I don’t really think that’s a solution. I think most of the people that are saying don’t see it as a solution either. Though, I think there’s a temptation to think of hyperinflation as kind of like a monetary neutron bomb. All the capital, all the riches and the wealth that you see around the world today.

The air conditioning, the high rises, the shopping malls with escalators filled with stores filled with goods to buy. All of that would still be there. It’s just that somehow the dollar hyperinflates and goes away and then magically somehow some other currency springs into being and goes forward. But actually, hyperinflation is going to be at the very end. It’s total collapse. It’s collapse of civilization. When people can’t buy food and energy. All sorts of social things will be happening because the people that are starving to death aren’t going to accept that fate, they will try to kill anybody else they think can lead to food.

John: So you’re suggesting we avoid that?

Keith: Yeah, for the record. Put me down as let’s avoid hyperinflation. Yeah.

John: All right. OK, so, Keith, let’s talk a little bit about what gives the dollar its value. Is it just our confidence that it will buy today what it bought yesterday? Or is there something more fundamental at work?

Keith: Yeah, people look at it and say, well, the dollar’s not backed by anything, therefore doesn’t have any value, therefore, the whole thing is a giant illusion. And then all we have to do is find the right factoid, publish that factoid and then once the public becomes aware, the whole thing will collapse. Aside from the fact that if the dollar was really that big a bubble waiting for its pin, surely it would have hit the pin by now.

So it’s kind of a little bit naive. It’s one of those things the world doesn’t work that way. But more fundamentally, yeah, there is something that gives the dollar the value and that is the struggles of the debtors. Every time the interest rate is dropped, and it has dropped many, many, many, many times over many, many, many years. It’s been dropping for 40 years since nineteen eighty one. Every timeit drops, it’s a renewed or additional incentive to borrow.

So if you didn’t want to borrow at 10 percent, they come back and say, OK, Mr. Flaherty, how would you like to borrow at nine and a half? And if you still say no to that, they come back and say, OK, how about borrowing at nine? How about at 8? And all the way down. And so whether or not consumers get lured into debt as one set of questions, which I don’t necessarily want to address today, but they’ve lured every business into borrowing. Every hamburger stand, every hamburger chain, every pizza place, every place that sells hot dogs and gyros and fine dining, and everything in between, is borrowing to build more, ever more capacity and ever more glorious palaces to welcome you in. So that’s number one. Number two, even if you weren’t tempted, if you’re running an old style, you know, whether it’s a steakhouse or whether it’s a fast food place and you decide, well, I don’t want quote-unquote to borrow, I’m going to let these idiots borrow. Well, the problem is you’re in a market that’s populated by these, quote-unquote, idiots.

I don’t think they’re idiots. That’s a different story. You’re in the market with them. They’re borrowing to expand their capacity and make their places more attractive. If you aren’t, you will go out of business because what you have is not going to be attractive to the customer. Everybody’s seen that faded old restaurant that looked like it might have been obsolete in nineteen eighty seven. And those places, there’s a few of them still alive. They’re just struggling and most of them have gone under by now.

So every producer of everything, every farmer, every miner, every distributor, every manufacturer, every business that uses capital in any way has borrowed in order to increase the capacity, which is what happens when the interest rate falls. They’re all in debt. They’re all in debt up to their eyeballs, which means they have to sell whatever their product is and enough of it to raise enough revenue, that net of expenses have enough profit to service their debts. When you pay the interest, forget paying the principal, which nobody can do anymore. When you pay the interest on your debt, the interest payment is coming from profits.

That is net of expenses. And so if you measure the dollar in terms of its purchasing power, which is a very popular idea. What can the dollar buy? That’s the value of the dollar. Well everybody who sells the things you can purchase is tripping over themselves to produce more and more and more. More and more goods that they’re eager to dump on the bid price, which is pushing down the price in order to desperately raise revenues to service their debt and stay alive because something ugly happens to you if you don’t service your debt.

And that is the bank comes and forecloses. They take away your asset. And in many cases, the business owners personally cosign. So they’ll take away his house and life savings as well. That is what is giving value to the dollar, the struggles of the debtors.

John: Just a follow up question on that, does this phenomenon increase the rate at which industries or businesses sort of consolidate and grow into these large conglomerates? I have a couple cousins in the dental industry and they’re talking about how you get these mega companies that are just buying up dental practices across the country and they talk about having more buying power or negotiating power with the insurance companies. I mean, there’s that always exists. But does this lower interest rate contribute to an acceleration of that trend?

Keith: Yeah, because the big companies can borrow to buy the small ones. So small company is thinking, OK, the interest rate just ticked down. Should I have a second dental chair in my office? A big conglomerate is thinking the interest rate just ticked down. Should I buy one hundred more small dental offices? And so, yeah, you’re going to get as the interest rate goes down and more and more stuff is going to consolidate onto fewer and fewer but larger and larger balance sheets. Absolutely. I see that as part of the trend.

John: And of course, if you get big enough, then you can qualify for bailouts. Right.

Keith: You’re too big to fail. That’s right. You can’t be allowed to fail.

John: All right. So back to the deluge of debt. Obviously the calls for hyperinflation growing louder and louder, Keith, is there a magic signal or a threshold or a ratio that we should be keeping an eye on as a predictor of when we’ll see hyperinflation?

Keith: There’s a number of economists who have looked at countries whose currencies have gone through hyperinflations and they’ve looked to see what’s the trend of debt or debt to GDP. And then they try to say, well, you know, if you get over 200 percent you know you’re at risk or whatever. I don’t think there’s a ratio per se, and particularly given that the interest rate affects the government’s ability to service the debt. So everyone says, well, look the government’s ability to pay the interest, interest is going to consume all available tax dollars.

Yeah, but if the interest rate ticks down, the Paul Krugman’s of the world are very smug. They’re smirking when they say, look, I haven’t seen him say this in a few years and I haven’t added it up recently. But a couple of years ago, well into the crazy post-crisis spending from the last crisis, “Look, the government debt service as a percentage of GDP or percentage of tax revenues has never been lower.” Yeah, that’s because you put your thumb on the scales, you pushed down the interest rate.

And of course, the interest expense is the total debt times the interest rate. And the interest rate falls, that debt service expense falls. So debt to GDP doesn’t necessarily signal anything. What I think people should be looking at, it’s not a magic number. Well, if we get to this many trillions of debt, we’re dead. Or this debt to GDP. I think what people should be looking at is, “why is the interest rate collapsing and what does that mean?”

It means that businesses are not bidding up interest. There’s nothing that’s happening in the economy that says my business prospects are so good I’m willing to borrow money even at above the current market rate and businesses competing with one another and pushing the interest rate up. Whatever forces that in a normal world that keep the interest rate in balance have been disabled. And businesses only borrow generally in a downtick in rates. That’s why the rate keeps going down, is because demand for credit is soft or nonexistent.

When the rate goes up and demand picks up again when the rate goes down and people should be asking a lot more questions about why is that so? What is it about the economy that businesses don’t want to borrow or cannot borrow or have no business case to borrow on an uptick in rates only in the downtick? What does that mean? And then there’s a statistic, a concept that I like to quote, that I didn’t coin this concept, but apparently, I’m the only one talking about it, because if you google it, my articles come up and that is marginal productivity of debt.

That’s not debt to GDP. It is how much additional GDP is added or GDP to debt It’s how much additional GDP is added. Or change in GDP divided by how much for the marginal dollar of debt that’s added. So it’s one thing to say, well, we have 30 trillion dollars in debt in this GDP. It’s another to say when we borrow a fresh new dollar of debt, how much do we add to GDP by doing so? And that’s a number that should be over one.

Right. Borrowing should be additive to the economy more than the amount added. So if it’s exactly one think of consumer spending. You borrow a dollar by putting it on your credit card. You buy a dollar of goods. One dollar of GDP is added for one dollar spent. So for one dollar borrowed equals one dollar spent. So GDP and marginal productivity debt goes up as one. But we’re in a place now where that’s been falling since at least 1950.

Why is that? That means that we’re obliged to borrow ever more dollars to get, for ever more squeeze we get ever less juice. More and more borrowing, and the borrowing becomes frantic and frenetic. We’re getting less and less GDP juice out of it. Why? Well, think about borrowing on your credit card the next month. You want to borrow, you have to borrow to make the payment on the first month, plus you’re borrowing another dollar to buy a dollar worth of goods.

So you’re borrowing a dollar and let’s say the interest rate is 10 percent, makes the math easy. You’re buying $1.10, but you only get a dollar worth of GDP added. And so this unproductive debt is hanging about the economy’s neck like an albatross. And I think people should be keeping an eye on marginal productivity of that. I think it’s a travesty that I’m the only one talking about marginal productivity of debt, with a few exceptions here and there.

There are a few voices of reason out in the wilderness, but largely nobody in the mainstream is talking about it. If you Google it, Keith Wiener’s coming out on top. And that’s not because my name is that big. That’s because all the big names are would rather redirect your attention to something else.

John: Well, I think it’s important to point out that there’s not much more room for the interest rate to fall. We’ve talked a little bit about what happens in negative interest rate land and things get a little screwy.

Keith: Just ask the Swiss about how much more room there is to fall. You could have the 10 year bond, I think they had negative 50 basis points at one point. It’s perked up at the moment, but it can keep falling.

John: So all this leads to the important question, Keith, are we screwed or is there a way out of this?

Keith: Bend over and kiss, no I’m just kidding. Tere is the way out of this, but not in the current regime. There isn’t a dollar trick in the dollar universe that will fix this. The debt has to keep going up and going up exponentially. We’ve talked about that. The debt is bearing down more and more burden, know more and more burden of that is bearing down on everybody’s shoulders. They lower the interest rate, but with a lower interest rate, lowers return on capital and the thing is just grinding away and it’s consuming capital.

We’ve talked about consuming capital as well. So there’s no way out from within the paradigm. There is a way out, which is gold. Gold is the extinguisher of debt. If you pay a dollar of debt using a dollar. The dollar itself is an IOU. The dollar itself is the debt. You’re paying the debt by paying another debt and all you’re doing is shifting it around and the total debt keeps on growing. That’s the pathology of the system.

Gold is the extinguisher of debt. If you owe somebody a debt and you pay in gold that not only are you out of the debt loop of the debt goes out of existence. However, gold has nothing to do with the monetary system today. That was the brilliance, evil, but the evil genius of Roosevelt’s move in 1933 to make the dollar irredeemable. And then with Milton Friedman whispering in his ear, Nixon drove the last nail in the coffin of the gold standard in 1971, making it irredeemable even to foreign central banks.

And so we have this system in which gold has completely vanished. It has no economic effect. If party A, buys gold from party B, or you could spin the same fact the other way. Party B sells gold to party A. Either way, it has no effect on the monetary system, no effect economically, no effect on the debt. That gold is not extinguishing any debt. It’s just simply trading hands between two third parties. You have to bring gold back into the system as a monetary asset.

Things have to be financed, productive businesses have to be financed in gold and those productive businesses have to pay their debts in gold and get out of this. But one final thing I want to add to this is that it should be clear by now that whenever governments, whether they allegedly intend good or not, the alleged unintended consequences. Leaving that aside, whenever the government says this is what we want you to do, it could be Diocletian or for that matter, Nixon declaring a cap on wages or prices.

It could be a Biden saying we’re going to set a floor under wages. You have to pay at least this. It could be a banana republic central bank saying our currency will be worth at least as many dollars. It could be the Swiss National Bank and their peg failed when they said the franc will be worth no more than this amount of euros, whenever the government tries to force people, or for that matter, the mass-murderous communist regime under Mao in China, as I understand it, went door to door. Like they sent guys with machine guns to go door to door to steal everybody’s gold. They got some gold, of course, people got caught. Either they were party loyalists or they got caught sort of red handed. The gold was in the house and they knew if they didn’t hand over voluntarily, they’d be shot. But by and large, you don’t get gold that way. What you get is people to bury it deeper. They have it buried in the backyard because they’re afraid of their regime.

And then when the regime starts to do that, they dig it up and they pick the hole twice as deep. You can’t get gold to circulate by declaring all the dollars, now, gold’s now going to be fifty thousand dollars. Gold didn’t circulate when it was two hundred fifty dollars. It didn’t circulate when it hit just about two thousand dollars. It’s not going to circulate when it hits fifty thousand dollars either. You need a market in which people have an incentive to voluntarily to choose to put their gold into the market.

And that’s not to spend. People mistakenly think about the root of the gold standard is people spending their gold. Today gold is a capital asset. People don’t want to spend their capital. Generally, gold is not income. You have to get gold into the market financing something productive, and you have to have a voluntary means of doing that. And offsetting the price of this i.e. the interest rate. You need a gold bond market to finance productive things and you need to go bond market to exchange or swap the outstanding paper debt and replace it with gold debt. The paper debt cannot be extinguished with the gold that can be extinguished.

And that’s one of the underappreciated economic ideas, is a voluntary way of getting gold into the monetary system by financing things. That is the way out of this.

John: Do you know anyone trying to do that?

Keith: Yeah, I’ve heard of this monetary something or other company that’s trying to do something like that. But leaving that aside, I guess the one comment I want to close on is whether or not you think that we’re taking the exact right approach. Nobody else is even asking the questions. I mean, that the world is in such dire straits and, you know, that so few people are even focused on asking the questions that lead to the solution is part of why our straights are so dire.

John: Well, life is good in a bull market, is all I can think to say.

Keith: Gold’s going up, buy gold that’s it, right.

John: Keith, thanks for another batch of great insights. That’s all the time we have today. Thank you for joining us on The Gold Exchange Podcast.